Sensex PE May Look Cheap... But It's Not - The 5 Minute WrapUp by Equitymaster
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Sensex PE May Look Cheap... But It's Not

Apr 27, 2017
In this issue:
» Market Cap of Indian Listed Companies Touches Record High
» Where Are the Markets Headed Next?
» Market Roundup
» ...And more!

00:00 Chart of the Day

Sarvajeet Bodas, Research analyst

The BSE Sensex and NSE Nifty are at all-time highs. The BSE Sensex closed comfortably above the magic figure of 30,000 for the first time. The midcap and small-cap indices are trading at insane valuations.

In euphoric times like these, investors find reasons to buy stocks - growth stories, stock re-ratings, margin expansion, new opportunities, etc.

I had an interesting conversation with my friend last week. His rationale was simple: 'Midcap and small-cap indices are trading at PEs of around 32 and 70 times. Very expensive. But look at the BSE Sensex and NSE Nifty. Trading at 22 times. This means plenty of opportunities in the large-cap space.'

That's how investors justify valuations. They say the current PE is still less than in 2007-8. During the January 2008 peak, the Sensex PE was around 28 times. They further say this is just the start of the bull market and, top-down, the market looks attractive.

Ten Year Sensex PE

Here's what Tanushree wrote about valuations and returns:

  • The current valuation of the index - more than 22x - is rare. Over the past two decades, the NSE Nifty has traded above 22x only nine times. And when it does, buying even the biggest blue chips has come with a huge downside for long-term investors. On five out of the nine occasions, the index lost money over a two-year period. So the historical data suggests there is currently a 60% chance of losing money in bluechip stocks.

Here's another interesting observation.

The market may look reasonable from a top-down approach. But individual stocks look either fairly valued or expensive from a bottom-up perspective.

Why?

Remember, the index comprises several sectors. Some sectors pull down the overall valuations.

How?

Consider the commodity, energy, IT, and PSU bank sectors. These sectors trade less than the index valuations and contribute more than half of the total profits of the index.

In other words, the high weights of low-PE stocks or sectors camouflages the expensive stocks. Looking at the markets top-down - that is, looking at the broader indices - valuations look reasonable.

But it's better to forget the indices and use a bottom-up (a stock-specific) approach.

This is the StockSelect team's approach. They focus on the underlying business. Its earning power, the business model, growth opportunities, and valuations.

As per the latest December 2016 audit, StockSelect has a success rate of 79.9%. So with this approach, that's four winners for every five recommendations for the last fifteen years.

According to Tanushree, 'You can't buy the best blue chips by following index trends. Rather, you need to take a contrarian view on the best blue-chip businesses.'

Learn more about that here.

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02:30

Other than the high valuations, the record high close of the market yesterday has taken it to a few other milestones too.

The combined market capitalisation of Indian listed companies is now within touching distance of the US$2 trillion mark. In dollar terms, it is now at the highest it has ever been - US$1.94 trillion. That's just 3% lower than the coveted US$2 trillion mark.

Notably, only eight other countries in the world now have a market value higher than India's.

As per reports, the BSE Sensex' rise along with the rupee's appreciation has also meant that since the beginning of 2017, India has become the best performing market among its global peers so far this year.

03:05

With the bulls cheering on, one question is topmost on the minds of most investors - 'Where are the markets headed next?'

One look at business media shows that despite the steep market rise and the expensive valuations, most analysts remain optimistic future prospects and about a further rise in markets. And there is no dearth of stories of why this should be the case.

Amongst all this high decibel cheering in the market, we'd like to remind of you of a rather sobering quote from Warren Buffett that couldn't be more appropriate for the time - "The future is never clear; you pay a very high price in the stock market for a cheery consensus. Uncertainty actually is the friend of the buyer of long-term values."

Remember it as you plan your market investments.

03:40

Talking of super investors like Warren Buffett, do you know who the super investors of India are?

Not just who they were...but how were they picking stocks? Which stocks were they picking? Why were they able to make a killing in the stock markets while ordinary investors never seemed to make any serious money?

My colleagues Rohan and Kunal just made getting access to all of these insights easier than ever.

They compiled all of their interviews for the Superinvestor Project into a special report called The Superinvestors of India.

The report will make a wonderful addition to your value investing library.

Click here for a free copy. May the lessons bring you long-term investing success.

04:48

The Indian stock markets were trading flat at the time writing on the back of mixed activity across most index heavyweights. At the time of writing, the BSE-Sensex was trading down by around 35 points. Gains were largely seen in auto and IT stocks.

04:56 Investment Mantra of the Day

"Unless you can watch your stock holding decline by 50% without becoming panic-stricken, you should not be in the stock market." - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Sarvajeet Bodas (Research Analyst).

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